This post is on China Shenhua (01088.HK), an energy company and one of the FT/Xinhua 25 index. It’s more about things to consider in investing in Chinese state owned businesses (SOBs) than a stock recommendation.
Introduction
It operates coal mines, power plants, railroads and ports. It mines coals in central China, transports them via own railroads or national railroads to market for sales, or to power plants (most in eastern China) for power generation.
Here’s a list of assets owned.
It’s a really really profitable business. Its 2007 revenue was RMB82 bn (including coal segment RMB56 bn, power segment RMB 24 bn), 50% growth from 2006. Net profit was RMB24 bn. See income statement below.
Ownership
This is the interesting part. The listed company was part of the Shenhua Group, which is a coal energy mammoth with dozens of subsidiaries. Below is part of the org chart.
The group owns 74% of the list company.
The group itself, with RMB411 bn in asset and RMB 141 bn in revenue in 2008, is one of the most profitable state owned business.
Implications
Here’s an excerpt from the 2007 annual:
“The Company’s standard of corporate governance has been recognized in the capital market and the Company has won various awards such as the award of “2006 Best Corporate Governance in Asia” («Finance Asia»).”
To me it’s an oxymoron. For an individual investor, if it’s owned 3/4 by the parent company which is in turn owned by the Chinese government, why is corporate governance even relevant? All you can do is to trust that the parent company (hence the government) will keep it profitable. The good news is such company would rarely bankrupt.
Several implications of the story:
- Market economy
the market economy is this case would hardly work. Suppose you are one of the Shenhua managers (BTW, most of them held government positions) trying to maximize profit for shareholders, you won’t know what to do when the group tells you to pay above-market price for coal purchase, or hold longer for receivables, etc. They won’t do that being responsible, but it’s hard to know.
Or the governments says that you should sell coals to steel plants or power plants for less to help them overcome the economic downturn, since they are also owned by government. It’s socialism at its best.
- Stock market
this also illustrate why some guys advocate government supporting the stock market (though the premise is absolutely false). The Chinese stock market is government-driven, because the government has a lot in it. For stock pickers, it takes a quite different skill set.
- Environment issue
China is short of oil and natural gas but coal abundant and uses a lot of coals for power generation. The immediate issue is carbon emission and global warming, which is also a petroleum problem.
In a market economy, the government would have to adjust the incentives for the economics of the clean energy to work. For example, I seriously think the U.S. should hike the gas consumption tax, like Demark, besides the cap & trade.
The Chinese government, with its immense and somewhat skewed market power, can take a different approach. It’s a much simpler process in China to allocate land for wind and solar sites (the government, hence the people, owns the land collectively), maybe also biomass for incremental power generation. I didn’t do the math, but it would be worth it even with some heavy subsidies to begin such a national industry of tomorrow.
P.S. for investment decisions, look here.
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